New crude transport rules to boost rail costs

20 October 2013 – New rules will boost costs to transport crude by rail in North America as trains are forecast to carry as much as 2 million barrels a day, about equal to what flows daily from Norway.

“You’re going to see a massive flood of spending to get ahead of these government regulations,” Jerry Swank, managing partner at Dallas-based Swank Capital, said during the Bloomberg Link Oil & Gas Conference in Houston yesterday.

Regulators in Canada and the U.S. imposed emergency requirements and may seek stiffer rules after a runaway train carrying crude derailed and exploded on July 6 in Lac-Megantic, Quebec, killing 47 people.

Energy companies are transporting more oil on rail cars as new pipelines are delayed and improved drilling methods extract more North American oil. Across the continent, trains are forecast to move as much as 2 million barrels a day of crude by the end of 2014, according to pipeline operator TransCanada Corp. (TRP) That’s roughly the same as Norway’s daily production or the combined output from U.S. offshore and North Dakota fields, the latest U.S. Energy Information Administration data compiled by Bloomberg show.

Transport Canada issued emergency directives for transporting hazardous cargoes after the July derailment of a train operated by Montreal, Maine & Atlantic Railway Ltd. in Quebec, including requiring two train operators, locks on cabins and ensuring that brakes are properly applied. The department is reviewing whether to impose stricter labeling of hazardous materials.

Better Tanks

The U.S. Pipeline and Hazardous Materials Safety Administration in September also proposed making DOT-111 tank cars, the kind that crashed in Quebec, less prone to rupture.

Rail shipments of oil from Western Canada are forecast to quadruple by the end of next year from 224,000 barrels a day as new loading terminals are built to get oil-sands crude on trains, according to a report by Peters & Co., a Calgary-based investment bank. The amount of rail-shipped Bakken crude to the east and west coasts is poised to jump fourfold this year, according to an analysis by Wood Mackenzie Ltd.

Refiners have used rail to take advantage of U.S. domestic oil that was about 15 percent cheaper than imports for more than two years since the start of 2011, according to figures compiled by Bloomberg. Accessing cheaper inland supplies through rail made it more profitable to pay transportation costs that are higher than by pipeline.

Continental’s Role

Continental Resources Inc. (CLR), the most active driller in the Bakken shale, is transporting 75 percent of its crude in rail cars, Harold Hamm, chief executive officer of the Oklahoma City-based company, said at the conference. The company boosted its reliance on rail due to a lack of pipeline capacity in North Dakota, according to a U.S. Securities and Exchange Commission filing.

“The good thing about it is it goes to the market faster and directly where you want it and it doesn’t have to go the pipeline route,” Hamm said.

The attractiveness of trains over pipelines wanes as differences between oil prices across the continent narrow, Swank said. “Spreads have never been this volatile,” he said.

Rail will be a “long-term phenomenon,” as producers seek flexibility and pipelines will remain dominant transporters of crude, said Robert Pacha, senior managing director at New York-based investment bank and fund manager Evercore Partners Inc. (EVR)

Facing increasing competition from rail, pipeline companies have scrapped or delayed proposals for new lines as operators struggled to secure long-term contracts from shippers, including the cancellation announced May 31 by Kinder Morgan Energy Partners LP (KMP) of its Freedom pipeline to connect California refineries with oil from West Texas.

Least Risky

Pipelines remain the least risky way to transport crude, Pacha said. Railways suffer spills 2.7 times more often than pipelines, according to the Washington-based Association of American Railroads.

Railroads are moving more oil partly because pipelines are taking longer to get approved, Alex Pourbaix, president of energy and oil pipelines at TransCanada, told reporters at an Oct. 16 conference in Calgary, where the company is based.

“I do not believe if you care about the environment, if you care about safety, if you care about the cost of transportation, none of that makes any sense, long term,” Pourbaix said. TransCanada’s $5.3 billion Keystone XL line has faced delays amid a U.S. review that has stretched more than five years.

Future regulations for moving crude by rail probably won’t be a “nail in the coffin” for rising shipments, as operators implement their own safety procedures in advance of the rules, Evercore’s Pacha said at the Houston conference.*Rebecca Penty, Bloomberg News